RE: Waiting for the Bubble to Burst?

- This insightful information is brought to you by the talented Megan Aller, Account Executive with First American Title. With a Bachelor of Applied Science (BASc), Analytical Chemistry, she knows her data!

Waiting for the bubble to burst? Here’s a snapshot of how prices are formed in Metro Denver.

Supply and demand are the two variables that determine price in real estate. Often times when I hear buyers concerned with the potential for a real estate bubble to be forming underneath of their largest financial asset they believe that rising prices alone are what create the bubble. Prices are a function of the relationship between supply and demand, and while rising prices are a component of a bubble the existence of an over supply of homes needs to also be present for the appropriate conditions to exist. We are lacking inventory.

If you have been anywhere near Denver since 2012 this shouldn’t be the first time you have heard about the inventory shortage. The first question I am often asked is what would be a normal amount of inventory or what would be average? How many homes should be for sale? Well, that’s a tricky question- because each variable is dependent on each other to determine normal. Let’s take a quick review of our market over the last 15 years.

The graph above shows the Months Supply of Inventory- also known as the ratio of buyers to sellers. As you can see there are two different sets of peaks and valleys. The build up from 2005, the recession that hit in 2007 and carried through until our market began to recover quickly in 2012 and by 2013 Denver dropped into an extreme seller’s market. The characteristics that continue to fuel our market are the lack of inventory and a surplus of buyer demand.

Reviewing this metric- months of inventory, Denver has on average had a 4.5 month supply of inventory, which is lower than the national standard of a balanced market which as determined by The National Association of REALTORS as a 6 month supply. Using that specific definition, 6 months for a balanced market or a ratio of for every one buyer in the market they should have approximately six homes to choose from- this allows us to track how far we are from a balanced market.

As you can see we have been far short of the required inventory for 6 years- based on the 1:6 ratio we should be closer to around 13,000 units in the winter months and 24,000 units in the late spring based on buyer activity. As of the beginning of this year, we only had 3,500 units for sale, which means we had 26.9% of the inventory required to offset demand. Let’s revisit how bubbles are formed- for a bubble to burst, we must have rising prices and rising inventory, beyond the point of balance. Before we become concerned about a bubble we need to have more inventory that what we would need for a market in balance.